1. Objectives:
By the end of this section you should be able to:
1) State and explain the characteristics of a contestable market
2) Explain how markets can become more contestable
3) Explain using a diagram the implications of contestable market theory
4) Application to a transport industry
2. Concept developed by Baumol in 1970’s
Unpinned UK transport policy over past 30 years
Not a market structure alongside the 4 others we have looked at
The objective of contestability is to bring about the conditions of
a perfectly competitive market in any such market structure
All markets CAN be economically efficient if they are contestable
No perfect examples of a contestable market exist in reality
What matters is the THREAT of ENTRY of new suppliers – this
may be enough to change the behaviour of existing firms
Contestability may force firms away from profit maximising
behaviour to something else such as sales revenue maximisation
3. •Lack of barrier to entry and exit – this should be
government’s policy
•A market which is open to ‘hit and run competition’
•Absence of sunk costs (key characteristic)
•Lack of brand loyalty
•Lack of collusion/price fixing
•Perfect knowledge exists
•The number of firms in the market is not important/relevant
in terms of economic efficiency
•Only makes normal profit in the LR
4. De-regulation – reducing statutory barriers to
entry to liberalise a market i.e. Open skies
agreement March 2008
Tougher competition laws – acting against
predatory behaviours by existing firms and tough
rules against cartels
Changing nature of technology – this has
brought down entry costs in some market i.e. Low
cost airline industry
5. •The monopolist charges the
profit maximising price P
Price
MC
AC
P
•If the market is contestable then
it will be vulnerable to ‘hit and
run entry’
•A monopolist will try and avoid
this happening by setting price
equal to AC at P1 so that there
are no abnormal profits to attract
new firms
P1
D=AR
•Hence only normal profits are
made in the long run
•No one in the industry has an
advantage over anyone else
Q
Q1
Output
MR
6. Discuss the extent to which air passenger transport is a
contestable market. [20]
8. DATA RESPONSE JUNE 2008
Cii)
Comment on the extent to which the rail freight
industry is contestable (4)
d)
Discuss the effects of increasing competition in the rail
freight on the economic efficiency of the freight transport
industry
(6)
9. January 2012 – Data Response
Discuss the extent to which air passenger transport is a
contestable market. [5]
10.
11.
12. •Availability of take-off and landing slots
•Necessity of entering a new route on a large enough
scale to achieve acceptable cost levels
•The costs of leasing new fleets of aircraft
•Securing an air operator’s licence from the EU
•Contracts with ground-handling companies
•Retaliatory behaviour by rivals i.e. Expansion in flight
frequency, cuts in fares
•Overcoming existing customer loyalty achieved by
companies who have exploited first-mover advantage
on specific routes
13. Analyse the characteristics of a contestable
market. [15]
Analyse the relationship between contestability
and efficiency within a market. [15]
JUNE 2011
Discuss the extent to which the UK bus market is
contestable. [20]
Discuss the extent to which air passenger
transport is a contestable market. [20]
Notas do Editor
Possible analysis as to why it is contestable includes: Deregulation in 1986 removed a significant legal barrier to entry (L1) – the requirement to prove a “need” existed for new services (L2). New companies are now only required to obtain an operator’s license by registering their company and meeting basic safety standards (L2). In theory, by removing such legal barriers, this increased contestability as it enabled new firms to enter the market more easily (L3). New entrants are able to bid for subsidised routes (L1) through the tendering process (L2). THIS RESULTS IN NEW FIRMS BEING ABLE TO ENTER MARKETS (L3) ie contestable The bus market in some areas resembles monopolistic competition (L1). In such markets, there are a large number of firms and each is too small to engage in predatory pricing and take advantage of economies of scale (L2) ie in monopolistic competition, barriers are low (L2). HENCE OTHER FIRMS ARE ABLE TO ENTER THE MARKET (L3) ie it is contestable. Possible analysis of why it is not contestable includes: In practice, despite deregulation, the industry is not contest-able. Local oligopolies have emerged with dominant firms existing in different areas. This has resulted in barriers to entry existing which have reduced contestability. Possible barriers to entry include: Dominant incumbent local bus firms (often with substantial economies of scale) can lower their prices to a much greater extent than new, smaller firms. Imperfect information exists with potential entrants often unsure of what profitable opportunities exist and which routes they should operate to maximise profits. To gain such knowledge, firms may be placed at a significant cost disadvantage. Sunk costs do exist in the form of advertising of new routes and new company services, partly to overcome the brand loyalty which exists Whilst legal barriers may be lower than they were 25 years ago, there are still safety standards for rolling stock which form a barrier to entry as new firms have to meet these safety standards as otherwise they will not be allowed to enter the industry Accept relevant oligopoly theory AS LONG as this is in the context of contestability. In other words, analysis here takes the form of oligopoly reducing contestability due to high barriers to entry. Likewise accept analysis of barriers established by local monopolies.
RESEARCH/PRESENTATION TASK:This case study was based on an article in the Guardian Newspaper in 2006. Using the internet and some newspaper websites do some research to find out what has happened to Rail Freight from 2006 to 2013. What investments have been made in upgrading the system? (make reference to some mentioned in the case study, did they happen etc)How much more freight is being carried (make reference to statistics)What are the plans/aims for the future in terms of carrying freight via rail Prepare a short powerpoint presentation which you will share with your classmates.
Five marks are available in total for this question:Up to 2 marks for recognising why the market MAY be contestable: Legally, in theory, firms have the right to compete for franchises(in other words, certain legal barriers have been removed).Accept simple reference to “legal barriers have been removed”OR “firms are able to bid/compete for franchises” OR “lower legalbarriers” ‘Open Access’ operators are able to compete in the market(against franchise holding firms) eg Grand Central and Hull trains. Accept a general comment that privatisation has removedbarriers to entry (and hence increased contestability) Leasing of trains has increased contestability due to lowerbarriers (lower start up costs) As brand loyalty is not an issue in the train passenger market thisis one barrier which does not exist–hence the market iscontestable (except in the case of Open Access market) There are a number of competing firms (a pool of potentialentrants) wanting to enter the marketUp to 2 marks for recognising why it MAY NOT be contestable withexplicit reference to examples of barriers which exist: high set up/start up costs (including cost of meeting health andsafety laws) economies of scale of established firms imperfect information. a lack of slots at many main line London stations restrictions on where passengers can be picked up/dropped off limited availability of rolling stock a shortage of trained drivers for companies to employ On some routes there is not a pool of potential entrants Possible predatory pricing/limit pricing1 final mark is available for a clear summary, evaluative conclusionwhich answers the question directly. For example: A simple conclusion which states that it is clear that the railindustry has limited contestability OR that contestability variesover time. Despite the high prices, as there are so few non-franchisedoperators in the market, the market is clearly not very contestable The extent to which the market is contestable depends upon howfar barriers have been reduced Level of contestability will depend upon size of incumbent firms
